How the Arab Spring Is Affecting Oil Prices, and Where Investors Should Put Their Focus

The Arab Spring has forced governments to spend more on citizens, thereby putting a floor under the price of oil. Investors should focus on countries whose governments feel threatened by the uprisings.

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Crude oil prices hit a four-month high this week on the back of rising tensions in the Middle East and North Africa and the unfortunate murder of the US ambassador to Libya. Added impetus on the upside was given to oil by the announcement of more money printing (QE3) by the Federal Reserve, which said it would launch an open-ended commitment to purchase $40 billion of mortgage-backed securities monthly.

The global benchmark for oil, Brent crude oil, jumped to about $117 per barrel. It maintained its roughly $18 premium to US-based WTI crude oil which was trading at $100 per barrel a couple days ago. Non-futures investors can easily participate in the oil market through the use of exchange traded funds. The ETF that tracks Brent crude oil futures is the United States Brent Oil Fund (BNO), and the ETF that tracks WTI crude oil futures is the United States Oil Fund (USO).

The real story behind the story in the oil market, however, is the ongoing Arab Spring, which is sweeping throughout the Middle East and North Africa, pushing aside some regimes and threatening others. The countries whose governments feel threatened by popular uprisings, such as Saudi Arabia and the other Gulf states, are where investors should put their focus.

Saudi Arabia in particular is key because it accounts for more than three-quarters of the world's spare oil production capacity. So it is very important to note that the kingdom is no longer a price 'dove' in OPEC as it has been for decades. It has joined Iran, Venezuela, and others in being a price 'hawk.'

The reason behind the change in attitude is simple: Arab Spring.

Like its neighbors in the Gulf region, Saudi Arabia has gone on a public spending spree to appease its restless citizens. It has sharply increased outlays on subsidies for items like food, fuel, and housing in an attempt to appease its citizens. In 2011, the kingdom raised its domestic spending by $129 billion – the equivalent of more than half its oil revenues.

Much of this increased spending will go toward upgrading the country's infrastructure. Take electricity, for example. Saudi Arabia has revealed plans to spend more than $100 billion on power plants and distribution networks by 2020. The kingdom has also set a goal to electrify 500,000 new homes that are being built in an attempt to mollify political unrest among its population of 27 million people.

This spending spree led the International Monetary Fund and other analysts to estimate that the kingdom and other Gulf countries need oil to be selling between $80 and $85 a barrel in order for the governments to balance their budgets. This is up, in Saudi Arabia's case, from a mere $25 per barrel a few short years ago!

Unfortunately for oil consumers, this trend looks set to continue in years ahead. According to the Institute of International Finance, by 2015 the Saudi government will only be able to balance its budget if oil prices are at $115 per barrel if current spending trends remain in place.

So in effect, with the Arab Spring forcing governments to spend more on their citizens, it has put a floor under the price of oil. OPEC will do everything in its power to keep the price above the budget breakeven points for governments in the Gulf region.

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